Now that Foxconn Technology Group (富士康) has been victorious in its four-year battle to purchase Sharp, Chairman Terry Gou (郭台銘) needs to buy one more item: a knife.
Gou is set to put down at least ¥484 billion (US$4.3 billion) and, according to a person familiar with the matter, was willing to go as high as ¥660 billion. He is adding five new Japanese divisions and a whole lot of debt to his huge, but lean, Taiwanese manufacturing empire.
If Gou wants to cover those liabilities and recoup his costs, he would need to do more than simply convert those businesses to the Foxconn Way.
Photo: AFP
While Gou has likely pledged not to break up the company as part of his pitch to Sharp’s board, history has shown that what one says and what one does are not always in sync.
After various incarnations, Sharp’s five divisions are consumer electronics, energy solutions, business solutions, electronics components and displays. Dividing Sharp into its constituent parts and then valuing those parts against their industry peers based on projected sales gives the Japanese firm an enterprise value of about ¥1.8 trillion. Subtract items like debt and minority interests, and Foxconn is sitting on a little over ¥1 trillion in unrealized equity value.
To help unlock that, Gou should jettison at least two divisions.
When Foxconn first made a play for Sharp back in 2012, it was the displays unit that appeared most enticing. Fast forward a few years and that division is still trumpeting its IGZO technology, a chemical process that makes display screens brighter and reduces battery drain. It was a modern marvel, but since then, the world has moved on. Apple is investing in exactly the same area, which potentially could cut Sharp out of the picture entirely and even Foxconn is building its own large display-technology factory in southern Taiwan. Sharp also did not invent IGZO and thus shares licensing rights with its competitors, including everyone’s nemesis, Samsung.
Based on the average enterprise value-to-sales ratio of industry peers and Sharp’s own revenue forecasts, the displays division is worth about ¥435 billion. Not too shabby, but considering there is unlikely to be another buyer and that Gou could slash costs, he might as well hang onto it and see what value he can extract.
Using the same methodology puts Sharp’s business solutions unit at ¥356 billion. That is the division that makes point-of-sales terminals, cash registers and printers. Although it is not very sexy and by sales is the second smallest, it actually brings in the most profit. That should not be a reason for Foxconn to keep it. Indeed, it is an opportunity to spin it off to a strategic investor or private equity firm.
Energy solutions is the group that makes solar cells and air conditioners. It is the smallest unit and has not turned a profit for the past three quarters. Sharp had forecast it would be in the black this fiscal year, but realized earlier this month that was not going to happen.
However, Gou has something of an emotional attachment to renewable energy and environmental technologies, so while a sale would make sense, he would probably hold on to it.
That leaves two key divisions — consumer electronics and electronics components. One of them should go.
For many, Sharp is synonymous with high-end consumer electronics. The company’s decades of experience and marketing nous has built a reputable brand that spans televisions to white goods. That is precisely why this is the division Gou should offload.
Foxconn is already in the business of supplying to consumer electronics names such as Sharp and its rivals. To then turn around and compete with those same customers by owning a brand is a recipe for disaster. Acer tried it back in the 1990s before spinning off Wistron and Asustek followed a few years later when it created Pegatron.
Gou has built Foxconn into a global behemoth by looking after his customers and deliberately not competing with them. Now is not the time to alter that strategy. With an enterprise value of ¥331 billion, consumer electronics is not the fattest pig in the pen, but there are plenty of would-be buyers (read Chinese companies) that have both the money and desire to pay a premium for a famous global brand.
For all Gou’s talk about LCDs and their ilk, it is hard not to suspect it is the electronics components division he is most excited about.
Contributing 19 percent of sales, it is neither the biggest nor smallest unit, but it does make some of the most lucrative widgets in the whole tech industry, including camera modules, analog chips and air quality sensors. With an operating margin around half that of its peers, this is a business that is clearly punching below its weight, most likely because it has been bogged down in a slow-moving Japanese company.
Furthermore, component makers are routinely valued much higher than other companies in the sector, so ascribing a calculated worth of ¥525 billion is hardly a stretch.
Gou knows that the electronics components division is a diamond in the rough. He can leverage its technology to boost sales and, unshackled from the other units, it should be worth a lot more. In the end, that value could rise to a point where it pays for Foxconn’s acquisition of the entire company. That is a Sharp move.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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